IN THE PAST few years, the Bureau of
Internal Revenue (BIR) has issued rulings which effectively revoked
long-standing precedent rulings which have laid down consistent
interpretations, principles and applications of tax rules and tax
treaties to specific transactions. Needless to say, this has caused a
great degree of uncertainty among taxpayers -- both Filipino
corporations as well as multinational companies -- leading them to
re-examine the tax impact on their business models, corporate structure
and long-term business plans.
One such ruling, which has caused quite a
stir in not a few boardrooms, was the one issued by the International
Tax Affairs Division (ITAD) of the BIR in January 2013 but published
only last month. This ITAD ruling involved a multinational company (MNC)
that is a leading manufacturer and seller of fast-moving consumer goods
(FMCG).
This MNC is a non-resident foreign corporation which, in line with its
global operating model, set up a branch in Singapore that serves as its
Asia Pacific regional operating entity responsible for developing,
executing and managing strategic functions across various markets in the
region. More importantly, said regional operating entity is the
licensee of various intellectual properties and enters into
manufacturing and distribution contracts in many Asian countries to
ensure that its products are available for sale to the customers in each
of the markets it serves.
Consistent with its global model, the Singapore branch entered into a
five-year contract with a related Philippine entity (Manufacturing Co.)
to perform raw materials sourcing, manufacturing, packaging and other
related services for the manufacture of the products. From time to time,
the MNC would deliver product orders and specifications to the
Manufacturing Co., which, after production, would store the finished
products until delivery to such parties as may be instructed by the MNC.
The purchase price of the products would be determined according to the
transfer pricing laws and be based on cost plus a certain mark-up.
The MNC also entered into a five-year distribution agreement with
another related Philippine entity (Distributor), appointing the latter
exclusive distributor of the products in the Philippines. The
Distributor would place product orders to the MNC at a distributor’s
price, which would be set such that it would allow the Distributor to
earn a certain operating margin based on net sales. The Distributor
would then be responsible for entering into contracts (not binding on
the MNC) with wholesalers, retailers, government offices, self-services
or any trade channels (the “Customers”), whether wholly by itself or
partially through other entities engaged by it. The Distributor would
then invoice the Customers to which it would sell direct from its stocks
and extending acceptable credit and trade terms. It would also make the
necessary arrangements for the warehousing, transportation and delivery
of the products to the Customers. The Distributor would be allowed to
contract with third parties for distribution of items that do not
compete with the products of the MNC.
In essence, BIR-ITAD ruled that, since the Manufacturing Co. and the
Distributor habitually maintain the products in their premises for the
MNC, and regularly deliver these products to third parties on behalf of
the MNC, both the Manufacturing Co. and the Distributor are deemed
permanent establishment (PE) of the MNC. Accordingly, income derived by
the MNC from the sale of the products in the Philippines attributable to
said PE shall be subject to Philippine income tax. In effect, the MNC,
as a foreign corporation, shall be taxed as a resident foreign
corporation subject to income tax based on its taxable income (i.e.,
gross income less allowable deductions).
The above ruling runs contrary to a line of precedent rulings --
involving substantially the same business model and transactions --
issued by BIR-ITAD in 2000, 2002, 2004 and 2005.
In issuing the contrary ruling, BIR-ITAD concluded that in the case of
the Manufacturing Co., even though it has no authority to conclude sales
contracts on behalf of the MNC, it habitually maintains in the
Philippines a stock of goods from which it regularly delivers goods on
behalf of the MNC. BIR-ITAD reached this conclusion after noting that
the contract with the Manufacturing Co. is for five (5) years, thus
satisfying the condition of habitualness and regularity. BIR-ITAD also
noted that, since the MNC provided the Manufacturing Co. with monthly
forecasts for the products to be manufactured in accordance with its
purchase order specifying the quantities to be produced, this showed
that the products belong or will belong at all times to the MNC. In
addition, since the Manufacturing Co. stored the finished products and
delivered the same based on instructions by the MNC, the Manufacturing
Co. is deemed to be a PE of the MNC as it habitually maintains and
regularly delivers products on behalf of the MNC.
In the case of the Distributor, BIR-ITAD also concluded that because of
the term of the distribution agreement as well as by reason of the fact
that the Distributor warehouses the products, the Distributor performs
business activities and maintains products for the MNC with habitualness
and regularity.
More importantly, BIR-ITAD did not consider the Manufacturing Co. and
the Distributor as brokers, commission agents or other agents of
independent status doing business for their own account so as not to
consider them as PE of the MNC.
In the case of the Manufacturing Co., BIR-ITAD explained that since the
manufacturing contract merely allows it manufacture products for the MNC
but does not authorize it to negotiate or conclude sales contracts with
third parties on behalf of the MNC, it cannot be deemed a broker or a
commission agent to the general public.
With respect to the Distributor Co, BIR-ITAD conceded that it is acting
as commission agent, but its independent status is overridden by the
fact that its business activities as exclusive distributor are and will
be devoted wholly or almost wholly on behalf of the MNC.
BIR-ITAD went through great pains to lengthily lay down the basis for
arriving at its conclusions, but we believe that it adopted a limited
view in understanding the MNC’s business model and transaction flow with
the Manufacturing Co. and the Distributor. The business and transaction
structures utilized by the MNC are based on bona fide corporate
structures in pursuance of legitimate business objectives and practices,
which, in turn, are anchored on prevailing consumer patterns, market
conditions, manufacturing and supply chain models.
In addition, the pricing structures adopted by the MNC vis-à-vis its
Manufacturing Co. and Distributor are based on concrete transfer pricing
studies used across various markets. We believe that rather than
immediately putting into question legitimate business and transaction
models, tax authorities can adopt a wholistic approach by understanding
the business context in which taxpayers operate. In the above ruling,
looking at the transfer pricing angle, i.e., evaluating whether the
transfer price or mark-up on services is indeed arm’s-length based on
certain factors, might have been a more comprehensive view.
That certain arrangements are exclusive are and often times based on the
confidential and proprietary nature of the products or services
involved rather than an indication that the parties are inclined to
manipulate the price. The proprietary nature of the products or services
indicates the use of intellectual properties for which royalties may be
paid, and thus, corresponding taxes would also be due.
A distribution arrangement can also be exclusive because the
distribution facility was built by the Distributor based on the
specifications of the principal, and thus, no other principal would be
inclined to use the same or pay the higher distribution fee.
In other words, tax authorities would be in a better position to
evaluate taxpayer’s transactions and determine areas in which to improve
collection if they also took time to understand the business context in
which the taxpayers operate and conduct their activities.
The author is a director with the tax advisory and compliance
Division of Punongbayan & Araullo. P&A is a member firm within
Grant Thornton International Ltd.
source: Businessworld
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